Your firm is contemplating the purchase of a new $580,000 computer-based order e
ID: 2685668 • Letter: Y
Question
Your firm is contemplating the purchase of a new $580,000 computer-based order entry system. The system will be depreciated straight-line to zero over its five-year life. It will be worth $60,000 at the end of that time. You will be able to reduce working capital by $75,000 (this is a one-time reduction). The tax rate is 35 percent and the required return on the project is 15 percent.
If the pretax cost savings are $200,000 per year, what is the NPV of this project?
If the pretax cost savings are $150,000 per year, what is the NPV of this project?
At what level of pretax cost savings would you be indifferent between accepting the project and not accepting it?
Your firm is contemplating the purchase of a new $580,000 computer-based order entry system. The system will be depreciated straight-line to zero over its five-year life. It will be worth $60,000 at the end of that time. You will be able to reduce working capital by $75,000 (this is a one-time reduction). The tax rate is 35 percent and the required return on the project is 15 percent.
If the pretax cost savings are $200,000 per year, what is the NPV of this project?
If the pretax cost savings are $150,000 per year, what is the NPV of this project?
At what level of pretax cost savings would you be indifferent between accepting the project and not accepting it?
Explanation / Answer
Dep= 580,000/5= $116000
Gross profit 200000
Dep (116000)
EBIT 84000
Tax(.35) (29400)
NI 54600
OCF= 84000+116000-29400= $170600
After tax salvage= 60000(1-.35)= $39000
cashflow for 5 years
0 1 2 3 4 5
Capital invst.-580000 39000
NWC 75000 -75000
-505000 170600 170600 170600 170600 170600
134600
NPV= -505000+ 170600/1.15+(170600/1.15^2)+(170600/1.15^3)+(170600/1.15^4)+(134600/1.15^5)=$ 48979.3
IF the Gross profit= 150,000
OCF=$138100
NPV= -505000+ 138100 /1.15+(138100 /1.15^2)+(138100 /1.15^3)+(138100 /1.15^4)+(102100/1.15^5)=$-59965.74
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